When will Indiana hit the tobacco tax tipping point?

Almost every elected official in the state has agreed road funding is the number one priority in the 2016 session, ever since an engineering group released a study giving Indiana’s roads and bridges a D+. Note: (Editor’s note: That report was NOT scored by CTB McGraw-Hill.)

With weeks until the short session starts, the funding proposals are being unveiled every other day. They are coming so fast and furious that the last one ended with a Paul Walker tribute.

We’ll try to dig into all of them here on the blog, but something piqued our interest in the House Republican plan announced today: a cigarette tax hike.

What do Newports have to do with new streets? Well, when you’re moving more money from the gas sales tax toward roads, you have to replace those dollars with something else, as Speaker Brian Bosma told the Indy Star.

To compensate for the loss to the general fund, Bosma and Soliday are looking at increasing a state tax on cigarettes, which they said would go to the state’s Medicaid program and free up money in the general fund currently used for that purpose.

“More than 60 percent of our Medicaid expenses in the state are linked to smoking,” Bosma said. “If there was an offset with the cigarette tax — which has been discussed — it would be linked directly to Medicaid funding.”

I’ve been fascinated with the cigarette tax since 2007, when it was raised to help pay for the Healthy Indiana Plan. Indiana — and every other state in the union for that matter — is trying to hit a subtle masse shot here. The challenge is trying to discourage a deadly behavior through negative incentives. But at the same time, everyone is balancing budgets on the taxes that behavior generates.

So when do we hit the point of diminishing returns?

This chart shows tobacco tax revenue over the last 14 years as well as per capita sales of cigarette packs.*

The first date worth looking at is Fiscal Year 2002, when we hiked our tobacco tax from 15.5 cents to 55.5 cents. Revenues went through the roof, and cigarette purchases went down about 20 percent.

Not much changed again until FY 2008, when our tax went up to the current rate of 99.5 cents per pack. Again, revenues soared and there was another 20 percent drop in sales.

Since then, the state has successfully reduced smoking to historic lows, but that also means we collected about $80 million less in 2014 than we did in 2008. That’s a lot of money. So the truth is, lawmakers might actually need to increase the cigarette tax anyway to boost revenues again. It’s like putting on a fresh nicotine patch.

But is the $1.00 increase going to put us past the tipping point? Not likely.

Another 20 percent reduction (to 50 packs per capita) like we saw during the last two increases would still mean our tobacco tax revenue would be well over $600 million. In order for Indiana to earn less than we are currently raking in, sales would almost have to be cut in half.

That’s not happening overnight, but as smoking becomes more and more of a social taboo, it might eventually happen.

The lesson here is that taxing models of the past are only going to take us so far. Declines in fuel tax revenue have hindered every state’s ability to pay for roads. Gas consumption rates aren’t going to trend up ever again. Likewise, we’re not going to see a reverse in the smoking rate decline.

The only difference is that it’s much more politically acceptable to tax unfiltered than unleaded.

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*Note: This is total tobacco tax revenue, which includes chewing products, cigars, pipes, and more. Still, 90-some percent of this revenue stream comes from cigarettes.